While courts and lawyers in Texas continue to struggle with many of the same issues developing across the country, there are also some issues with precedent more unique to Texas, that are currently developing and will impact the framework of insurance and insurance litigation in the state.

Responding to Time Limit Demands in Texas in the Age of “Nuclear” Verdicts and Settlements

Over the past several years, there has been a growing number of what are called by many “nuclear verdicts,” or exceptionally high awards that surpass what should be a reasonable or rational amount. The risk of such verdicts has risen significantly. In fact, a long-term study of verdicts from 2010–19 found that the median nuclear verdict increased by 27.5% over the ten-year study period. Six states, including Texas, are responsible for 63% of nuclear verdicts, far greater than their share of the total US population. Legal experts define a “nuclear verdict” as one that exceeds USD10 million; however, the verdicts, as seen below, are often exponentially larger. Further, the verdicts since 2020 have become even more eye-popping. These verdicts often include disproportionately large non-economic damages awards, but the real hallmark of nuclear verdicts is often juror anger.

Recent examples from Texas

In 2023, a Texas jury awarded a woman USD1.2 billion after ruling that she was the victim of revenge porn. The woman filed a harassment lawsuit against her former boyfriend alleging that he posted intimate pictures of her online to “publicly shame” her after a break-up. Her lawyers in the case said the settlement is a win for victims of “image-based sexual abuse”. The lawyers had originally asked the jury for USD100 million in damages.

In December 2021, a jury entered a verdict of USD301 billion against a sports bar in Corpus Christi, Texas. The suit alleged that after drinking at the bar a patron ran a red light and hit another vehicle killing the occupants. Investigators determined that he had a blood alcohol level of .263 and that he had 11 drinks at the bar.

In 2022, a Dallas County jury decided that a communications company should pay the victim’s family and estate USD7 billion in punitive damages and USD337.5 million in compensatory damages arising out of the murder of an 83-year-old customer by a former technician. The technician had pleaded guilty to the murder and had been sentenced to life in prison. The family accused the company of hiring the technician without verifying his employment history and ignoring a series of red flags about his behaviour, which included theft of other customers credit cards and cheques from elderly female customers. The verdict eventually became a judgment for the lowered amount of USD1.1 billion, and an even lower judgment in the amount of USD262 million was entered by agreement. In 2023 the matter was resolved for an amount within the insurance coverage.

The effect on time-limited settlement demands

The presence of these and similar verdicts have resulted in increasingly larger settlement demands to insurers during litigation. The demands, regardless of the type of dispute, consistently include a summary of the nuclear verdicts rendered in or near the venue in which the case is tried, as well as information about other settlements the attorney has achieved recently. They typically invite insureds to have their personal counsel review the demand and address it with the carrier directly. And often they admonish insurers to not believe that the purpose of the letter is merely posturing; rather, it is the claimant’s earnest desire to make the carrier realise the significance of their dispute.

The carrier’s duty to respond to the time-limited demand

The purpose of the demands under Texas law is to seek to expose the carriers to amounts awarded against their insured in excess of the limits purchased. Texas law has, for nearly a century, recognised a negligence-based action for failure to settle based upon the court’s holding in G.A. Stowers Furniture Co. v American Indemnity Co., 15 S.W.2d 544, 547 (Tex. Comm’n App. 1929, holding approved). In Stowers, the court established an insurer’s duty to settle based on the “control” given to and exercised by the carrier under the policy terms. Later cases have summarised the Stowers elements as follows

• the claim against the insured is within the scope of coverage at the time the offer is made;
• the demand is within policy limits; and
• the terms of the demand are such that an ordinary prudent insurer would accept it, considering the likelihood and degree of the insured’s potential exposure to an excess judgment.

If these conditions are met, and a judgment or reasonable settlement is entered in excess of the policy limits, a non-settling insurer may be liable in excess of its limits. A failure to settle may also give rise to an action under the Texas Insurance Code.

Evaluating time-limited settlements

The proliferation of nuclear verdicts and nuclear settlement demands has made evaluating what qualifies as a reasonable demand under the law significantly more difficult. It is important for any insurer evaluating a time limited settlement demand to consider the following.

First, insurers need to be cognisant that the demand letter and the insurer’s response will be front and centre in the coverage litigation, should there be an excess judgment. Evidence concerning the evidence the claimant put on at trial, as well as the trial defence, and the carrier’s (and the insured’s) conduct during settlement negotiations is in play here. Recent case law has made clear that each demand is evaluated in the context of the case, at that juncture.

Second, the insurer’s claim investigation will be presented to the jury in the Stowers action. In response, did the insurer:

• Conduct its own verdict search?
• Determine that the verdicts and settlements presented by the claimant’s attorney as support are pertinent?
• Conduct any independent evaluation of the dispute via mock jury exercise or similar?

The insurer must remember that the information obtained in this investigation will be seen by the jury in any subsequent action.

Third, in deciding whether to accept a demand, insurers must always bear in mind that a suit against them for excess liability is always a fact issue that is adjudicated after the judgment is entered against the insured, and the insured is potentially faced with economic catastrophe. The insurer’s liability will be judged by a jury of “Monday morning quarterbacks” who are aware of the demand, as well as the end result: a verdict that may well have made the local news (or worse).

The bottom line is that nuclear verdicts and nuclear settlement demands have made predicting what a jury will do on a particular set of facts significantly more difficult for carriers, which makes it significantly more difficult to prove after a verdict what a “reasonable” insurer would have done at the time. And the fact that these disputes present issues of fact for a jury to decide post-verdict, make it unlikely that the Texas Supreme Court will address the legal standard in any appreciable way in the near term. The standard will likely remain was the demand presented one such that an ordinarily prudent insurer would accept it. As a result, carriers need to ensure that they are fully considering all the available information when evaluating the demands they receive, regardless of how extreme they may appear at the outset. And, although by definition nuclear verdicts are unreasonably high, and even irrational, the presence and increasing likelihood of such verdicts will bear upon the Stowers jury’s determination as to whether the insurer acted reasonably in refusing to settle.

Can You Incorporate Extrinsic Contracts Into Policies? The Supreme Court of Texas Says Yes, but Beware!

In complex litigation that involves multiple parties, each of whom may be insured by one or more insurance carriers, how each party’s insurance policy interacts with underlying contractual obligations can raise questions with significant impact. The trend in Texas, especially since the Supreme Court of Texas’ opinion in In re Deepwater Horizon, 470 S.W.3d 452 (Tex. 2015), is that, when analysing coverage under a specific policy, courts will look to extrinsic contracts only if — and to the extent — the policy specifically calls for it.

The Supreme Court of Texas emphasised the significance of the policy language in ExxonMobil Corp. v Nat’l Union Fire Ins. Co., 672 S.W.3d 415 (Tex. 2023). The primary question the Court answered in Exxon was whether the required insurance limits in an underlying service contract were incorporated into the applicable umbrella policy. The Court held that the policy did not incorporate the provisions of the underlying contract with the specificity and clarity required by Texas law. 

The case arose out of an accident in which two employees of Savage Refinery Services were severely burned. Exxon hired Savage as an independent contractor to work at the Exxon refinery in Baytown, Texas. Their agreement was memorialised in a contract that required Savage to carry at least USD2 million in coverage and name Exxon as an additional insured. Savage fulfilled the insurance procurement requirements by obtaining two policies from National Union Fire — a primary general liability policy and an umbrella policy.

The Savage employees’ claim settled for USD24 million. About USD5 million of the settlement was paid out of Savage’s primary policies under which Exxon was an additional insured, including the National Union Fire primary policy, which exhausted. Exxon paid the remaining USD19 million out of its own pocket because National Union Fire denied coverage under the umbrella policy. National Union Fire asserted that the underlying contract required Savage to obtain only USD2 million of coverage, and the National Union Fire policies incorporated by reference that insurance procurement provision. This effectively reduced the limits of insurance to USD2 million.

It is no surprise that coverage litigation ensued. Exxon won in the trial court, which held that National Union Fire owed the remaining USD20 million to Exxon as an additional insured on the umbrella policy. The court of appeals reversed, holding among other things, that the service contract’s USD2 million insurance procurement provision was incorporated into the National Union Fire primary and excess polices.

The Supreme Court of Texas granted review, with the primary question being whether the minimum USD2 million insurance requirement set forth in the service contract was incorporated into the policies. Or, in other words, whether Savage’s whole tower of insurance applied to the loss or just the contractual minimum. The high court’s opinion begins with a brief overview of Texas law on whether, and to what extent, extrinsic contractual provisions can be incorporated into insurance policies. While there are cases on the issue going back as far as the 1880s, the 2015 Deepwater Horizon case addressed the question head on. In that case, the Supreme Court of Texas clarified that “we determine the scope of coverage from the language employed in the insurance policy, and if the policy directs us elsewhere, we will refer to an incorporated document to the extent required by the policy”. However, courts will not consider coverage limitations in underlying documents “unless obligated to do so by the terms of the policy”.

The Court seems to have chosen the word “obligated” with purpose, as at the outset of its analysis in the Exxon opinion, the Court warns: “Any venture beyond the four corners of an insurance policy must be carefully limited to the scope of that policy’s clearly authorized reference”.

With this approach in mind, the Court quickly concluded that Exxon was an additional insured under the umbrella policy issued by National Union Fire to Savage. The umbrella policy provided additional insured coverage to any additional insured covered by the primary policy. And the primary policy contained a blanket additional insured provision that covered any entity that Savage had agreed in a written contract to name as an additional insured. The Court noted that for purposes of determining who is an additional insured, the policy incorporated the underlying service contract with sufficient clarity.

The bigger question — what limit applied — came next. National Union Fire’s argument focused on the umbrella provision specifying that it does not provide “broader coverage” than the primary. Because the umbrella policy followed form to the primary, and the primary incorporated by reference the USD2 million minimum, the umbrella had no obligation to pay any excess amount. The Court rejected this argument holding that the term “broader coverage” referred to the type of coverage, not how much was available.

The umbrella policy, even considering the disclaimer of “broader coverage,” did not refer to the limits of insurance at all, much less specifically and clearly incorporate the terms of an extrinsic contract, as required under Texas law. Further, the Court noted that, even if the contract were adequately incorporated into the policy, the contract required only a minimum amount of insurance; it did not set an upper limit on the amount of insurance that could be procured and provided to Exxon as an additional insured.

Finally, the Court noted that National Union Fire’s interpretation of the policies and contract would defeat the general purpose of an umbrella policy, which is to provide additional limits of insurance if and when a primary policy is exhausted.

The practical takeaway from the Exxon case is that insurers and insureds are free to incorporate the terms of an extrinsic contract, such as a service contract with insurance procurement requirements, into an insurance policy. However, the parties must be certain that whatever policy endorsement is used clearly specifies the exact terms of the extrinsic contract that is to be incorporated. Texas courts will look to the extrinsic contracts. But, as the Supreme Court of Texas said in Deepwater Horizon — and demonstrated in Exxon — those extrinsic contractual terms will be incorporated into the policies only to the extent courts are obligated to do so.

Texas Courts Continue to Fix Boundaries on Adversarial Trials and Enforceability of Agreed Judgments

Texas courts and insurers are wrestling with issues surrounding whether and to what extent settlements or judgments resulting from circumstances other than conventional trials are binding on liability insurers. When liability insurers refuse to defend their insureds in lawsuits brought by third parties, insureds sometimes settle the claims, either with their own funds or by giving the third party an assignment of its claims against the insurer in exchange for a covenant not to seek recovery from the insured’s assets, but only from the insurance policy proceeds. In the not-too-distant past, Texas courts held that an insurer that wrongfully refuses to defend its insured is precluded from contesting the reasonableness of settlements or judgments, even agreed judgments, against the insured and is limited to contesting coverage. In State Farm Fire & Cas. Co. v Gandy, 925 S.W.2d 696, 714 (Tex. 1996), however, the Texas Supreme Court refused to enforce an agreed judgment against an insurer stating that “[i]n no event, however, is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on defendant’s insurer or admissible as evidence of damages in an action against defendant’s insurer by plaintiff as defendant’s assignee”. Id. The court refused to enforce the judgment against the insurer based on concerns about collusion, the integrity of the litigation process, and whether such judgments are an accurate reflection of the insured’s liability and the plaintiff’s damages. Gandy was limited to agreed judgments and courts applying Texas law continued, for example, to enforce settlements against insurers that denied coverage where there were no indicia of collusion involving a settlement entered into and funded by the insured after the insurer denied coverage. In the absence of collusion or distortion of the litigation process, courts also enforced – against insurers – judgments entered after underlying proceedings that were essentially prove-ups or default hearings where the insured put on no defence, ostensibly because it did not have the financial ability to defend itself.

Then, in Great Amer. Ins. Co. v Hamel, 525 S.W.3d 655 (Tex. 2017), the court revisited Gandy and examined what constitutes an adversarial trial for purposes of rendering a resulting judgment enforceable against an insurer. Rather than focus on the specific trial details of the proceeding giving rise to a judgment, such as whether the insured had a lawyer, whether that lawyer conducted a vigorous cross-examination, and whether the insured’s lawyer put on evidence, the court stated “[t]oday we clarify that the controlling factor is whether, at the time of the underlying trial or settlement, the insured bore an actual risk of liability for the damages awarded or agreed upon, or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects the plaintiff’s damages and thus the defendant – insured’s covered liability loss”. 525 S.W.3d at 666. It declined to enforce the underlying judgment against the liability insurer because, prior to the proceeding that resulted in the judgment against the insured, the insured had received a covenant not to execute against its only assets. The court held that the judgment was not enforceable against the insurer or admissible as evidence of damages against it in a subsequent trial. It also clarified that a formal, written pre-trial agreement that eliminates the insured’s financial risk is not always necessary or sufficient to disprove adversity. Rather, the presence of such an agreement creates a presumption that the judgment did not result from an adversarial proceeding, whereas the absence of such an agreement creates a presumption that it did. An insurer may overcome the presumption by demonstrating that, even though no formal non-execution agreement was entered into, the defendant/insured had no meaningful stake in the outcome of the underlying litigation. The plaintiff may overcome the presumption by submitting evidence demonstrating that the defendant retained a meaningful incentive to defend the underlying suit despite an agreement that eliminated the defendant’s financial risk.

Importantly, , the Hamel court held that, in cases where the insurer wrongfully refused to defend but the judgment was not binding on the insurer, the plaintiff could relitigate issues of liability and damages in a subsequent coverage lawsuit. The court reasoned that by wrongfully declining to defend or to litigate coverage early on, the insurer makes a complicated endeavour, such as a retrial of liability and damages, necessary. The court stated that while relitigation of underlying liability and damages issues is not a perfect solution, it is necessitated by the insurer’s wrongful refusal to defend. The court concluded that “under the approach we adopt today, the insurer will have the opportunity to challenge its insured’s underlying liability and the resulting damages, the abandoned insured is protected, and the burden on the plaintiff is fair”. 525 S.W.3d at 669.

The application of Hamel is still being worked out. In In Re Illinois Nat’l. Ins. Co., No. 22-0872, the Texas Supreme Court has been asked to clarify the circumstances under which the Gandy/Hamel rule of non-enforceability of judgments or settlements will be applied. The case involves a settlement and agreed judgment entered in underlying securities litigation in bankruptcy court. The settlement and judgment were entered into after an extended period of litigation. The settlement amount corresponded to the amount of the combined limits of liability of the applicable insurance policies, although the potential exposure to the debtor and related parties was much higher. The settlement agreement and judgment provided that the judgment debtor and related defendants would prosecute coverage litigation against the insurers to recover the settlement amount and that most of the recovery would be paid to the underlying plaintiffs. This prosecution and payment obligation was the consideration for a prospective release of the underlying plaintiffs’ claims against the judgment debtor and related parties. The action against the insurers was filed in state court in Harris County. The trial court subsequently considered various cross-motions for partial summary judgment filed by both sides, ruling against the insurers on whether the defendant insureds had suffered a loss and whether the judgment was binding and enforceable. The insurers sought mandamus relief in the court of appeals, which declined to grant the writ without opinion. The insurers then sought relief in the Texas Supreme Court. Briefing on the merits was requested and filed, and the case was argued on 24 October 2023. The case raises questions concerning the parameters of the non-enforceability and relitigation rules, particularly in the context of debtors in bankruptcy and non-recourse settlements involving claims against corporate officers and directors. Among other things, the Texas Supreme Court has been asked to modify and/or clarify its “no financial incentive” test in light of the unique facts presented in the bankruptcy context, specifically when directors and officers of a bankrupt entity face personal exposure and the insurer has declined to fund their defence. It is likely that even after the court issues its opinion, Texas law will undergo significant development in the area of the enforceability against insurers of judgments not resulting from conventional trials.